The race to stay relevant

When First International Computer shut its Taiwan laptop assembly line in September, it became the last laptop maker on the island to relocate laptop production to the Mainland where its competitors have been cranking out computers for the last several years. "Relocating to the Mainland has become…inevitable," FIC Chairman Chien Ming told Taiwan's United Daily News.

Just as Beijing has successfully marginalized Taiwan politically (only 26 states recognize the island), the Mainland's rising economic stature is also backing Taiwan's economy into a corner. It has overtaken the US to become Taiwan's largest export market and is the island's largest trading partner.

The island of 22.7 million is now amidst an economic slowdown. Estimates for real GDP growth this year are between 3-4%, down from 5.7% in 2004, thanks to weakening exports, high global oil prices and uncertainty in the IT sector, the largest contributor to Taiwan's exports. Taiwan is now expected to post lower GDP growth than its emerging Asian neighbors this year; only Japan is growing slower than Taiwan.

Taiwan's weakening economic outlook has dented its stock market, which on September 24 saw the benchmark TAIEX index fall to its lowest in four months. The Taiwan dollar was not spared either that day, falling for the seventh week, its longest losing streak since 2001. Perhaps the most damning indicator lies in Taiwan's foreign trade surplus, which fell by half to US$430 million in August and dived 79% to US$1.17 billion for the first eight months this year. Taiwan's 2005 trade surplus has been estimated by its Ministry of Finance to reach a level between US$2.6 billion and US$3 billion, a 23-year low. For a small economy -such as Taiwan's, it needs to find a way to boost exports in order to sustain growth. With the developed economies of US, Japan and Europe in midst of their own slowdown, the Mainland is Taiwan's "only bright spot" according to UBS economist Jonathan Anderson.

Perhaps Taiwan's state of economic affairs is best summed up by Anderson who writes in an October 12 research report titled Taiwan in Limbo that the real story in Taiwan's is "'no story'…there's nothing that would make the economy particularly interesting ? Taiwan is inexorably slowing on the home front."

Preaching patience
While it is hard to directly link the island's economic woes to Taipei's "patience over haste" policy restraining Mainland-bound investments, many say Taipei's restrictions are dampening its economic prospects.

"The logic is simple: everyone goes to China to make money, why don't we?" said Philip Yang, a National Taiwan University professor and director of the Taiwan Security Research Center. "The country is gridlocked by political orientations that are trumping the simple logic of the economy."

Yang's sentiment is echoed by other experts. "If Taiwan opens up to the [Mainland] even more, we can boost the repatriation of capital and people," according to Miao Chen, an economist with the Taiwan Institute of Economic Research in Taipei.

The capital leaving the island heading north is no small change. Taiwan's officially-sanctioned China-bound FDI last year reached US$7 billion, or 2.3% of Taiwan's GDP, and roughly equivalent to Taiwan's total R&D investment in 2004. About one million Taiwan residents lived in the Mainland at the end of 2003.

UBS' Anderson calls the liberalizing of Taiwan's economic links with the Mainland the "single and most important potential boost for the Taiwan economy," a move that "would provide a much stronger incentive [to Taiwanese businesses] to stay at home."

Hollowed out
For the first time in decades, Taiwan's imports overtook exports in the first five months this year, a troubling sign for an economy based on exports. Yet the trend is hardly surprising for a country undergoing an industrial "hollowing out" as businesses, particularly high-tech companies, shift their production to the Mainland.

Policy analysts and economists say Taiwan's future depends on how well it restructures into a knowledge-based, service-oriented economy founded on innovation and other high value-added activities. While moving upstream, Taiwan's industries will also need to create recognizable brands for global markets, the experts say.

As for its place in the global IT supply chain, Taiwan can stay relevant if it retains the high-value headquarter functions, such as design and R&D, while moving capital-intensive production offshore (UBS states in a Oct 12 research report that Taiwan's higher value-added players are largely exempt from mainland pressure). Taiwan's niche in global IT may come ultimately by way of its experience in the Mainland, where it commands significant influence in the IT industry. Taiwan's know-how has been credited for birthing the Mainland's semiconductor industry, and Taiwanese fingerprints are unmistakable in many other mainland high-tech operations. By some estimates, as much as 70% of the Mainland's IT exports are produced under the guidance of Taiwan's experienced hand, while as many as 70% of mainland high-tech operations are run or owned by Taiwan-based companies.

"Taiwan's importance in the IT supply chain is becoming less and less unless you are talking about it in the context of China, because China's IT businesses are producing similar goods or are being run by Taiwanese companies," Chen said.

Taipei still wavering
Though Taiwan Premier Frank Hsieh said Taipei continues to ponder easing restrictions on mainland-bound investments in the semiconductor and liquid crystal display (LCD) panel sectors, among others, it has been trying to hold to the same line in other sectors for a long time now to little effect.

Tough rhetoric by Taiwan President Chen Shui-bian does not do much to raise hopes for changes either. Chen told Reuters in early October that he hoped talks about closer economic links between the two sides could continue, but he insisted as always that "Taiwan is not part of China".

What Beijing has on its side, however, is time, and with its growing political and economic stature, it is also counting on Taiwan's populace coming round in time to the view that there would be significant benefits in reunification, as the Mainland doles out preferential treatment to Taiwan-based companies, pandas and subsidized tuition for Taiwan students studying in the Mainland. The trouble is, the Taipei administration doesn't equate Beijing's moves with benevolence: "Taiwan is afraid that economic interdependence will be used by Beijing as a bargaining chip to ask Taiwan for reunification," Yang said.

It may be too late to stem the tide of economic interdependence between the two sides. Taiwan's businesses have crossed the Strait in droves, in spite of Taipei's feet-dragging on liberalizing the regulations on mainland investments.

"The ones who want to move to the Mainland have already done so. It's a matter of time before they all go," Chen said. "[Taipei] isn't stopping anyone; it's time to reevaluate the strategy."

That the Mainland has already lured those Taiwan companies suited for relocation to the cities of Shanghai, Suzhou, Guangzhou, Shenzhen and Dongguan means that Taiwan's mainland-bound FDI may not grow at the same blistering pace of the past. For the first eight months this year, Taiwan's FDI outflow to China slid 18% to US$3.6 billion, according to Taiwan's Chunghua Institution for Economic Research. It is worth noting that China is seeing a broad-based decline in its FDI inflow, receiving US$37.99 billion in the first eight months of this year, down 3% from a year ago.

"No linkage with Taiwan"
Taipei's stance on mainland investment has been self-defeating, most notably in the one-way trajectory of Taiwan's capital flight. As Taiwan-based businesses set up offshore entities in Hong Kong and Bermuda solely for funneling capital to the Mainland under Taipei's radar, the returns are not being diverted back in many cases, making Taiwan's economy the loser.

"These businesses and profits essentially have no linkage with the Taiwan government and society," Yang said. "The questions for Taiwan are: how to support the investment in China and how to manage the headquarters in Taiwan."

The stalemate between Taipei and Beijing over direct, cross-strait links has enormous costs too. Taiwan's Mainland Affairs Council (MAC) officials recently told reporters that Taipei and Beijing have made only "limited" progress on the direct charter cargo and passenger flights (however, two Taiwan-based carriers were recently approved to fly over mainland airspace, though Taiwan's own airspace is still off-limits to mainland aircraft.)

Apart from the time and the transportation costs of rerouting through third-party destinations, which amount to costs in excess of US$10 million annually, direct air links could boost the economy and jumpstart tourism, an industry whose development many experts are urging (the Mainland announced it would allow its citizens to visit Taiwan, but the latter has set strict limits on how many can enter the island).

Direct air links would also serve to encourage more mainland travel by Taiwan residents. "If we make it difficult to get to China, the reverse is also true – it will be difficult for people to return," Chen said. "The hollowing-out effect isn't just about manufacturing. It's about the people too. As people leave the island, there will be declining private consumption (which accounts for more than 65% of Taiwan's US$320 million GDP). We have to make it easier for people to move back and forth."

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